Southwest Airlines posts narrower 3rd-quarter loss

Future bookings look good, but only because of heavy discounting

By

ChristopherHinton

NEW YORK (MarketWatch) -- Southwest Airlines Co. posted a narrower third-quarter loss Thursday as passenger demand slowly returned from the lows seen earlier in the year, but discounted ticket prices, the falloff in business travel and higher jet fuel costs darkened the carrier's forecast.

"I don't believe the worst is behind us if for no other reason because of higher energy costs," Chairman and Chief Executive Gary Kelly said on a post-earnings call with analysts. "And there's no reason to believe that business travel will return any time soon to help bail us out."

Bookings for October, November and December are "quite good," but are discount driven, Kelly said. Visibility into the next year remains murky.

"But we're going to continue to work vigorously on implementing more new revenue initiatives and do all we can to control our cost," he said.

Shares of Southwest fell nearly 6% to close at $9.47. The stock is down about 18% over the past 12 months as the recession hit the travel business, taking an especially heavy toll on sales of higher-priced business class tickets.

Adding to the pressure, Standard & Poor's lowered its credit rating for the low-cost carrier by one notch to BBB from BBB+, saying lower demand and poor pricing would negatively affect its earnings and cash flow.

Southwest's cash balance fell to $902 million in the third quarter from $1.4 billion at the end of 2008.

For the three months ended Sept. 30, Dallas-based Southwest
LUV, +0.04%
said it lost $16 million, or 2 cents a share, compared to a loss of $120 million, or 16 cents a share, in the year-ago period. Operating revenue fell nearly 8% to $2.7 billion from $2.9 billion.

Excluding one-time items, the company said it earned $23 million, or 3 cents a share, in the period. On average, analysts polled by FactSet Research expected Southwest to break even.

"Sixty days ago, even a modest profit seemed unattainable," said CEO Kelly. "Despite the continuation of a depressed economy, our people fought hard and have staged an impressive revenue recovery from where we were in June."

To entice people to travel, Southwest lowered its airfare, bringing passenger revenue yield down 12% in the period.

Prices have been rising more recently, and the carrier noted a "modest" increase in its airfare earlier this week. To help raise prices further, the airline plans to keep seat capacity next year roughly flat with 2009.

Southwest will still take delivery of 10 Boeing Co.
BA, +0.36%
737-700 jets in 2010, but a like amount of leased planes will see their contracts expire at about the same time, said Chief Financial Officer Laura Wright.

That "allows for anywhere from zero to 10 aircraft retirements next year," Wright said, during the analyst call, providing "flexibility with our retirement schedule and ... the ability to adjust our 2010 plans if needed."

Fuel costs remain a major concern. For the quarter, fuel and oil expenses plunged more than 21% from a year to $826 million, but benchmark crude prices have since climbed and recently touched one-year highs.

For the fourth quarter, Southwest has hedged over 45% of its estimated fuel consumption, effectively in the low $70 per barrel range, she said. For next year, the airline has over 65% of its fuel hedged.

"If you take the forward crude and the forward crack ... we're modeling un-hedged [jet fuel prices] next year of about $2.32 a gallon, including taxes," Wright said.

In August, jet fuel for U.S. airlines cost $2.02 a gallon as benchmark crude fell about 5% to end the month at $68.45 a barrel.

Southwest has one of the more successful fuel hedging programs in the industry, helping the airline avoid some ancillary-revenue tactics its competitors have had to implement. CEO Kelly reaffirmed again Thursday that the company has no plans of adding a first or second check-on luggage fee.

The airline has implemented other revenue-generating tactics, such as fees for pets and "early bird seating." Annual revenue for additional checked bags and heavy bags could reach $40 million this year.

Unit costs during the quarter remained flat from a year ago at 10.67 cents a mile. Excluding fuel, costs rose 10% to 7.34 cents.

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